Budget Surplus

Budget Surplus Example

Let's take a look at an example of when the government has a budget surplus.

This budget surplus could have arisen in several ways. If the government was previously in a deficit, the government could have increased tax revenue by increasing the tax base (that is, enacting policies that created more jobs), or it could have increased tax revenue by increasing tax rates. If higher tax revenue came about due to an increase in the tax base (more jobs), then the policy was expansionary. If higher tax revenue came about due to an increase in tax rates, then the policy was contractionary.

The budget surplus may also have come about due to a decrease in government spending on goods and services. This would be contractionary fiscal policy. However, the budget could still remain in surplus even if government spending on goods and services increased, as long as that spending is less than tax revenue. An example of this might be a program to improve roads and bridges, thereby increasing employment and consumer demand. This would be an expansionary fiscal policy.

The budget surplus may also have come about due to a decrease in transfer payments. This would be contractionary fiscal policy. However, the budget could still remain in surplus even if transfer payments increased, as long as that spending is less than tax revenue. An example of this might be higher government transfer payments to increase consumer demand, such as stimulus payments or tax rebates.

Finally, the government could have used any combination of tax revenue, government spending, and transfer payments to create the budget surplus, so long as tax revenue was higher than government spending on goods and services plus transfer payments.

Primary Budget Surplus

The primary budget surplus is the budget surplus that excludes net interest payments on the government's outstanding debt. Part of the government spending each year is to pay interest on the accumulated debt. This net interest payment is put towards paying the existing debt and therefore is a net positive to government savings, rather than reducing it.

Let's take a look at an example of a primary budget surplus.

Policymakers and economists use the primary budget surplus as a gauge of how well the government is running the economy aside from the costs of borrowing. Unless a government has no outstanding debt, the primary budget surplus will always be higher than the overall budget surplus. The primary budget deficit will always be lower than the overall budget deficit because we remove a negative number (net interest payments) from the equation.

Budget Surplus Diagram

Have a look at the budget diagram below (Figure 1), which shows times the U.S. government had a budget surplus and times the U.S. government had a budget deficit. The green line is government revenue as a share of GDP, the red line is government spending as a share of GDP, the black line is the budget surplus or deficit as a share of GDP, and the blue bars are the budget surplus or deficit in billions of dollars.

As you can see, over the last 40 years, the U.S. government has run a budget deficit the vast majority of the time. From 1998 to 2001 the government ran a budget surplus. This was during the technological revolution that saw productivity, employment, GDP, and the stock market all rise very strongly. Even though the government spent $7.0 trillion during this time, tax revenue was $7.6 trillion. The strong economy led to higher tax revenues thanks to a larger tax base, that is, more people working and paying income taxes and strong corporate profits leading to higher corporate income tax revenue. This is an example of an expansionary budget surplus.

Fig. 1 - U.S. Budget¹

Unfortunately, the Global Financial Crisis in 2007-2009 and the pandemic in 2020 led to declines in tax revenue and massive increases in government spending to try to get the economy back on its feet. This resulted in very large budget deficits during these periods.

Budget Surplus Deflation

While higher tax rates, lower government spending, and lower transfer payments improve the budget and sometimes lead to a budget surplus, these policies all reduce demand and slow inflation. However, deflation is rarely the result of these policies. An increase in aggregate demand that expands real output beyond potential output tends to push the aggregate price level higher. However, declines in aggregate demand usually do not push the price level lower. This is largely due to sticky wages and prices.

As the economy cools companies will lay off workers or reduce hours, but they will rarely reduce wages. As a result, unit production costs do not go down. This leads companies to keep their selling prices at around the same level to preserve their profit margins. Thus, during an economic downturn, the aggregate price level tends to stay about where it was at the beginning of the downturn, and deflation rarely occurs. Thus, when the government is trying to slow inflation, they are generally trying to stop the rise of the aggregate price level, rather than trying to reduce it to the previous level.

Effects of Budget Surplus

The effects of a budget surplus depend on how the surplus came about. If the government wanted to move from deficit to surplus via fiscal policy that increases the tax base, then the surplus can lead to stronger economic growth. If the surplus was created via a decline in government spending or transfer payments, then the surplus can lead to a decline in economic growth. However, since it is politically difficult to reduce government spending and transfer payments, most budget surpluses come about via expansionary fiscal policy that increases the tax base. Thus, higher employment and economic growth are usually the results.

When the government raises more in tax revenue than it spends, it may use the difference to retire some of the government's outstanding debt. This increase in public saving also increases national saving. Thus, a budget surplus increases the supply of loanable funds (funds available for private investment), reduces the interest rate, and leads to more investment. Higher investment, in turn, means greater capital accumulation, more efficient production, more innovation, and more rapid economic growth.